Fund Transfer Pricing

KPMG d.o.o. BeogradFinancial Services Team2016

F T P

2© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

Contents

Introduction to IFRS 9 3The Journey 4Why now? 5Case study 6Why KPMG? 7Our approach 9KPMG gCLAS 10

Would you like to see more and

further than others in terms of

your profitability?

3© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

Contents

Page

Introduction to Fund Transfer Pricing (FTP) [4]

• What is FTP? [4]

• Internal transfer and ALM risks centralization [5]

Main targets of FTP [6]

Potential consequences of not having FTP [7]

Exemplary scope of work, timeline and modules [9]

Appendices

Why KPMG? [11]

4© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

- The FTP system groups together the financial risks generated by commercial transactions with in a Central Finance Unit (CFU). CFU is generally managed by the ALM/Treasury department, which has the necessary expertise and resources to assess and hedge the financial risks.

- This centralization of risks is done thanks to a system of internal transfers between the commercial (business) lines and the CFU. These internal transfers are made via the theoretical “purchase” of customer deposits from deposit centers and the theoretical “sale” of funds to loan centers. The pricing terms of such transfers constitute FTPs.

Introduction to Fund Transfer Pricing (FTP)Banks have realized the need for an effective transfer pricing system in order to manage funding, the balance sheet structure (financial or ALM risks), and risk adjusted profitability.

Taking into account decreasing market rates environment and the fact that majority of Banks NBI comes from Net interest income, the FTP system is crucial.

Source: National Bank of Serbia.Note: Annualized data.

Net Banking Income of Serbian Q3banking sector 2015Net interest income 73%Net fee and commission income 19%Net income from fin. transactions 5%Other income 3%Total 100%

What is FTP?- Fund Transfer Pricing (FTP) is a well known

practice in finance. It is a part of the overall management information, accounting and control system which includes: pricing, bud-geting and profit planning, ex-post profitabil-ity measurement (profit ability controlling) and ALM.

- It is a widely used and comprehensive tool in overall financial management. Some would say it’s crucial for effective and efficient not only financial but banking business manage-ment.

- FTP system serves as main tool for expost profitability measurement, i.e. profitabili-ty follow-up and controling per various axis (business units, products, branches, relation-ship managers etc.).

5© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

Introduction to Fund Transfer Pricing (FTP)Internal (theoretical) fund transfer and ALM risk centralization could be presented as follows

Figure 2 – ALM risks cantralization

Management Board

ALCO

ALM

Liquidity portfolio income

Liquidity mismatch

Interest rate mismatch

Funding cost

Reference rate

Reference rate

Liquidity premium

Liquidity premium

Other

Other

Interest rate gap

Liquidity gap

FX gap

$

€

¥£

FTP rate

FTP rate

Risk

Risk

Assets

Liabilities

Market

Market

Figure 1 – Theoretical internal transfers

ALM center

FTPFTP

Deposits

Process of commercial products internal pricing

Commercial loans

Notional investments / Replacement

yield for deposits

Commercial margin on loans calculated on the basis of FTPs

cost of funds

Commercial margin on deposits calculated on the basis of FTPs

replacement rates

Notional funding / Cost of funds for

loans

Commercial deposits

Funding

6© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member fi rm of the KPMG network of independent member fi rms affi liated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

Strategicgoals of FTP

• To defi ne funding cost for the assets and to calculateNIM for asset items

• To defi ne reinvestmentyield for the liabilities andto calculate NIM for liabilityitems

• To stabilize NIM for allcommercial deals bytransferring (isolating)interest rate, liquidity andFX risk from BUs to CFU

• To defi ne pricing benchmarkfor clients’ deals (pricingtool) and thus ex-anteprofi tability measurement

• To establish effi cient ex-postprofi tability measurementper various axis and thusto link budgeting andcontrolling activities

• To impact BUs salesstrategy through conceptof incentives (subsidies) viaManagement FTP

• To signalize a real, existingmarket conditions in termsof market prices of sourcesand alternative placements,and thus infl uencecommercial lines to “fi netune”the prices of theirproducts

• FTP should align risk-takinginitiatives of BUs withliquidity and interest raterisk exposure they create forthe whole Bank

• BUs take risk they cancontrol and manage

• BUs are responsible forclients pricing

• Fair assessment ofeconomic performance ofevery BU, i.e. commercialmargin then becomes thesole result of negotiationsby BU with customers

• Business people shallunderstand how theprofi tability is measuredand shall be motivated byprofi tability indicators

• FTP requires reliable ITsystem and support

• FTP requires comprehensiveFTP Policy and Methodology

Integration of FTP into general Bank’s

management system

What are main targets of FTP?

FTP changes the overall commercial mindset of the Bank

• Regulations on liquidity:

üMinimum liquidityrequirements from local regulator or from Basel III in form of NSFR and LCR requirement

ü Recommendations on Organizing Effective Liquidity Management

• BCBS requirements

• FSA requirements

• Best practices

Regulatory requreiments and

best practice

7© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member fi rm of the KPMG network of independent member fi rms affi liated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

What are potential consequences of not following/having FTP?

How we can help

Consequences of not having FTP system

Volatile result of BUs due to not transferred and not hedged liquidity and IR risk

Without FTP top management is not able to distinguish profi table BUs, segments, products, branches, front offi cers etc. from non-profi table ones

BUs are unclear on real margin of their products. Non-market based FTP overstates performance of some BUs and understates that of others and leads to “unfair” and ineffi cient performance-rewards decision

Overstated profi tability of non-funded products creates wrong incentives for BUs to disproportionally grow portfolio

Total level of liquidity and IR risk cannot be measured and managed. Bank bears hidden risk of maturity and IR transformation

Loosing money on products mispricing. Without FTP framework, based on actual maturity, some BUs are charged less than required rate to cover funding cost

Performance of ALM Unit cannot be measured and volatile fi nancial results of ALM-unit (realized liquidity risks or improper liquidity management)allocated back to BUs and distort their performance

We offer more than just FTP as is:

ü Comprehensive gap analysis concerning Bank’s current profi tability management approach

ü Benchmark analysis vs. best practice

ü Recommendations for improvement of Bank’s profi tability system

ü Journey beyond just FTP –OPEX allocation and Cost of Risk incorporation into products pricing

ü Completely new profi tability approach in order to reach targeted ROE and EVA

ü PMO in terms of selection and implementation of new FTP tool (engine)

We have developed the robust and comprehensive FTP framework in line with Maturity and Cash-fl ow Weighted Rate Approach (MCWR).

Liability Price Term

Rate[%]

Liability margin

Market rate based transfer procong method

Asset margin

Loan Price

Treasure margin for levarage managementMarket curve

What we offer:

8© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

Our approach to FTP is flexible and

customized, driven by the specific

needs, culture and strategic goals

of our clients.

9© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member fi rm of the KPMG network of independent member fi rms affi liated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

Exemplary scope of work F T P

Basic module Optimal module

Basic module Optimal module

Advanced module

Phase 1: Review of Bank’s current FTP model and gap

analysis

Review and gap analysis willbe conducted in the followingareas of the FTP model:

• Objectives and principles ofFTP system with taking intoconsideration requirementsregarding Bank’s business andfunding strategy

• Scope of FTP model applica-tion

• Components of FTP rates andmethods for their determination

• Operational processes inscope of FTP system

Phase 4: Development of detailed concept of new FTP

model

Development of detailed performance concept of target funds transfer pricing model. Developed solutions will encompass such aspects as:• Objectives and principles of

new FTP system• Components of FTP rates

and methods for their determination

• Methodology of assigningFTP rates to particular products groups

• Scheme of FTP system and division of task and competences.

PMO in order to help Bank to select and implement new

FTP tool (engine)

PMO by KPMG shall help Bank to select a comprehensive FTP tool (IT solution), which shall be used as FTP engine in order to calculate and store FTP rates, compute margins and produce various profi tability reports.

Such tailor made FTP tool shall meet “state-of-the art” fi nancial best practice.

The FTP tool is to be developed either as in-house solution or external solution provided by vendors the KPMG cooperated with.

Phase 5: Preparation of written Policy and

Procedures for new FTP model

Development of formal documentation for FTP model based on the concept prepared by KPMG and accepted by Bank, including the following:• Policy –describing new

FTP model methodology, objectives and principles for new FTP model, organizational units involved in FTP process with division of task and competences.

• Procedure –description ofmethods and rules of tasks execution by particular unites involved in the process.

• Training of staff.

Phase 2: Benchmark analysis

• Benchmark analysis of fundtransfer pricing modelsused by leading fi nancialinstitutions.

• During the benchmarkanalysis KPMG will reviewbest practice solutions forselected aspects of FTPmodels applied by the leadingfi nancial institutions.

Preparation of conclusions andrecommendations based onas-is and benchmark analyses.The recommendations shall bedivided into two groups:

• Key changes designed toensure security and consisten-cy of the FTP model in its keyfunctioning aspects.

• Potential improvements withaim to add new featuresand to adapt the model toapplication for wider range ofproducts.

Phase 3: Recommendations

10© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member fi rm of the KPMG network of independent member fi rms affi liated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

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F T P

11© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member fi rm of the KPMG network of independent member fi rms affi liated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

Why KPMG?

KPMG d.o.o. Beograd is the leading consultant of fi nancial institutions in Serbia. Currently, we perform audit and consulting for more than 2/3 of the banking market in Serbia.

The practice in Serbia has rich experience in providing advisory services to the entire spectrum of fi nancial institutions: banks, leasing companies, government bodies, foreign investors, insurance companies and other fi nancial institutions, agencies and other companies that operate in Serbia. Our team also covers Montenegrin fi nancial sector market.

KPMG d.o.o. Beograd currently has about 210 employees, including 9 partners. Our FS Team, responsible for clients in the fi nancial sector, currently has about 30 employees, including one partner, two senior managers and three managers.

12© 2016 KPMG d.o.o. Beograd, a Serbian limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved

© 2016 KPMG d.o.o. Beograd, a Serbian limitedliability company and a member firm of the KPMGnetwork of independent member firms affiliatedwith KPMG International Cooperative (‘KPMGInternational’), a Swiss entity. All rights reserved. Printed in Serbia.The KPMG name and logo are registered trademarks or trademarks of KPMG International.

Dušan Tomi , PartnerE: dtomic@kpmg.comT: +381 11 20 50 521

Sanja Ko ovi , Departmental Senior ManagerE: skocovic@kpmg.comT: +381 11 20 50 518

Ivan Cirkovi , ManagerE: icirkovic@kpmg.comT: +381 11 20 50 649

Contact us:

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thorough examination of the particular situation.